Citi, Paul Weiss Take Sting Out Of SEC’s $180M Settlement

8/17/2015

Law360

Ed Beeson

After the U.S. Securities and Exchange Commission announced a $180 million enforcement action Monday against two Citigroup units accused of misleading investors ahead of the financial crisis, legal experts said the settlement has some clear winners: Citigroup and its attorneys at Paul Weiss Rifkind Wharton & Garrison LLP.

Citi agreed to pay the amount to end a long-running probe into how the bank’s financial advisers allegedly made misleading statements and omitted key information when encouraging wealthy clients to buy up shares in a pair of now-defunct Citi-run hedge funds. According to the regulator, about 4,000 investors put up nearly $3 billion to invest in funds that were sold as safe alternatives to bonds, when in fact they were highly leveraged and complex instruments and deeply troubled by the start of the financial crisis.

Ultimately, the funds, known as ASTA/MAT and Falcon Strategies, imploded in 2008, causing billions of dollars of investor losses, the SEC said.

To settle the claim, Citigroup agreed to pay just under $140 million in disgorgement, plus another $39.6 million in prejudgment interest. Citi will also be responsible for coming up with a plan to distribute the funds to injured investors, and will bear all costs of doing so, the SEC said.

But beyond that, the SEC did not extract a civil fine or admission of wrongdoing from the bank, nor did it name any people involved in the alleged misconduct, including a fund manager whom the agency said was deeply involved in the mismarketing of the investment funds. A majority of the commission even voted to let the bank retain its status as a well-known seasoned issuer, despite the ongoing controversy over the commission’s use of such regulatory waivers.

“Investors lost billions of dollars after the funds collapsed, and Citigroup only has to refund the fees it took with interest,” Mark Rifkin, a partner at Wolf Haldenstein Adler Freeman & Herz LLP, said. “That’s a big win for Citigroup. It’s like dropping the cookie when you’re caught with your hand in the jar.”

The settlement essentially forces Citi to return the fees it collected from ASTA/MAT and Falcon investors. According to the SEC’s settlement, the two Citi units — Citigroup Global Markets Inc. and Citigroup Alternative Investments LLC — collected about $212.5 million in fees from investors in the funds, and previously returned about $72.6 million of that amount to them in compensatory payments.

“I don’t see it as much of a win for investors,” said Philip Aidikoff of Aidikoff Uhl & Bakhtiari, which previously scored a record $54 million arbitration award on behalf of investors in the ASTA/MAT funds. “The amount of money that was contained in the order was just pennies on the dollar.”

“Folks who pursued individual claims received multiples of what people are likely to receive now,” said Aidikoff, whose firm also beat back a Citigroup court challenge to the arbitration award, which also included $17 million in punitive damages.

A Citi spokeswoman declined to comment on the bank’s previous payments to investors. In a statement on the SEC enforcement action, she said Citi is “pleased to have resolved this matter.”

Attorneys said they saw the settlement — coming seven years after the hedge funds blew up and five years after news reports revealed the SEC’s investigation into the collapse — as a testament to both the bank’s resolve and the skill of its outside counsel.

“My guess is it is a bit of a high-stakes game of chicken,” Rifkin said. “I guess Citi convinced the SEC they were not going to blink.”

An attorney for Citi, Audra Soloway of Paul Weiss, did not immediately return a message seeking comment.

The SEC’s enforcement director, Andrew Ceresney, was not available for an interview, but said in a statement that firms cannot hide behind fine print in written disclosures to “insulate themselves from liability for their employees’ misrepresentations.”

“Advisers at these Citigroup affiliates were supposed to be looking out for investors’ best interests but falsely assured them they were making safe investments even when the funds were on the brink of disaster,” Ceresney said.

Despite the strong language of the statement, and the level of detail on the alleged misconduct in the settlement document, attorneys said they were still left wondering why the SEC concluded the case on terms that seemed less severe than other high-profile matters.

“I feel like there is a story that the SEC hasn’t told us about why they are settling for these amounts,” said Donald Hawthorne, a partner at Axinn Veltrop & Harkrider LLP who specializes in crisis-era litigation.

Citi’s defense appears to have been that everything it said in its prospectuses was accurate, according to Hawthorne. But the SEC’s allegations paints a picture of systemic sales practice violations at the bank, he added.

“It’s not like one or two sales people went off the rails,” he said.

Having the regulator explain why it sought disgorgement but not a civil penalty would be valuable, Hawthorne said. But so would naming people responsible for the alleged misconduct in a case like this, he added.

“If they want to change behavior, they have to name individuals,” Hawthorne said of the SEC.

The SEC sanctioned the Citi units for, among other things, willfully violating provisions of Securities Act of 1933 that bar fraudulent conduct in the offer and sale of securities and similar rules under the Investment Advisers Act of 1940.

But given what it also says about the allegedly false and misleading statements made to investors by the unnamed Citi fund manager and his staff, it would seem the SEC would have enough to support at least a charge of failure to supervise, according to James Cox, a Duke University School of Law professor.

“It’s one of these classic situations where paying money doesn’t have much value for deterrence,” he said.

The SEC is represented by Olivia Zach, Kerri Palen, David Stoelting and Celeste Chase.

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